Custodian independence test
The SEBI rule barring a custodian from serving a mutual fund if its sponsor or associates control 50% or more of the custodian's voting shares, or 50% or more of its directors.
In plain language
A custodian holds a mutual fund's securities and settles every trade on the scheme's behalf. If the same group that sponsors the fund also controls the custodian watching over it, that control loses its meaning.
SEBI closes that gap with a simple ownership test. If the sponsor, or companies connected to it, hold half or more of the custodian's voting shares — or half or more of its board is made up of people representing the sponsor's interests — that custodian normally cannot be appointed for that sponsor's mutual fund business.
The point of the rule is straightforward: a custodian is only useful as a check if it genuinely reports to nobody but the trustees and the investors it is meant to protect.
How it works
The threshold (Chapter 3, section 3.2.5): a custodian cannot be appointed for the mutual fund operations of a sponsor, its associate, or its subsidiary company if the sponsor or its associates control 50% or more of the voting rights of the custodian's share capital, or if 50% or more of the custodian's directors represent the interests of the sponsor or its associates — unless specific conditions set by SEBI are met.
All custodians must in any case be registered with SEBI under the SEBI (Custodian) Regulations, 1996, and are appointed by the trustees under a custodial agreement. An independent custodian's core job, beyond settlement, is to confirm that the securities are genuinely held for investors' benefit, and to track corporate actions — dividends, bonuses and rights — on the securities the scheme owns.
A worked example
Illustrative — the workbook states the threshold, not a worked ownership structure.
A sponsor group owns 45% of the voting shares of Custodian A and nominates 3 of its 8 directors (37.5%). Both figures sit below the 50% line, so Custodian A can, subject to the rest of SEBI's conditions, be appointed to the sponsor's own mutual fund, which has Rs 8,000 crore of assets under custody.
The same sponsor group also owns 60% of Custodian B's voting shares. Custodian B fails the independence test on the shareholding limb alone — it cannot be appointed to hold that sponsor's scheme assets, even if its board composition would otherwise have passed, and the Rs 8,000 crore has to be custodied elsewhere.
Why NISM asks about it
Chapter 3 (Legal Structure of Mutual Funds in India), section 3.2.5, sets out the custodian's role and this eligibility restriction. Expect a question that gives a sponsor's shareholding or board representation in a custodian and asks whether that custodian can be appointed — the 50% figure on either limb is the test.
Common exam traps
- Either limb alone is enough to disqualify — 50%+ of voting shares, or 50%+ of directors representing the sponsor's interest. It does not require both.
- The rule targets the sponsor and its associates, not the AMC or trustees directly — though in practice sponsor control often runs through these entities too.
- This is a control test on the custodian, not on the AMC. Do not confuse it with the rules on who may be appointed AMC or trustee.
- "Unless certain specific conditions are fulfilled" — the workbook notes the bar is not absolute; SEBI can permit exceptions on stated conditions.
Where this is taught
Free preparation for NISM Series V-DRelated terms
- Asset Management CompanyThe company that runs a mutual fund's schemes day to day — appointed by the sponsor or trustees with SEBI's approval, and paid a fee out of the scheme rather than a share of its profits.
- CustodianThe SEBI-registered entity that holds a fund's securities in accounts of its own and settles its trades, so the assets sit somewhere other than with the manager who decides what to buy.
- Mutual fundA trust registered with SEBI that pools money from many investors and invests it in securities on their behalf — not a different product from shares and bonds, but a different way of owning them.
- TrusteeThe party that holds a Category III AIF's trust deed when the fund is set up as a trust, appoints the investment manager and custodian, and receives the annual audit findings on the fund's behalf.